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Telcos already up for the dawn of a new age

The telco sector has been hitting its straps with several stocks recording multi-year highs as regulation settles down and companies position themselves for the national broadband network world.

The telco sector has been hitting its straps with several stocks recording multi-year highs as regulation settles down and companies position themselves for the national broadband network world.

Dominant Telstra has had steady rises in its share price since it finalised its billion-dollar deal with NBN Co and outlined plans for a cautious but confident acquisition program.

Telstra shares traded at $3.60 on Friday, continuing an 18-month recovery from record lows of $2.56 reached in late 2010.

The chief executive, David Thodey, recently confirmed Telstra would pay a fully franked 28? dividend for this and next financial year, but was unable to say what dividends would be after that. At current trading prices, that gives Telstra shares an 8.33 per cent yield.

"Telstra considers a majority of shareholders prefer capital return in the form of fully franked dividends," Royal Bank of Scotland analyst Ian Martin wrote in a note to clients. "A build-up in franking credit balance over the next three years may fund an additional 4? per share dividend in 2013-14 which would draw $500 million from excess free-cash flow."

"What would Telstra do with the remaining $2.5 billion in excess free-cash flow? A buyback would still seem to be a viable option, given it reduces the share base and amplifies earnings-per-share gains as NBN payments ramp up."

Martin expects Telstra to deliver pre-tax earnings of $10.5 billion this financial year, a 3.2 per cent increase on 2010-11.

Investors who have been holding Telstra shares continuously since it first floated in 1997 have now received $3.71 in dividends a share - 41? more than the $3.30 sale price.

Those who bought shares during the T2 sale in 1999 at $7.40, which coincided with the dotcom boom, have received $3.40 in dividends. They must hold onto shares for another 14 years to break even, unless dividends are increased.

And those who bought shares at $3.60 in the final government sale in 2006 have received $1.54 per share. It is just seven years until T3 owners break even.

Telstra dominates the market because it is very liquid, with 12.4 billion shares on issue, and has a market capitalisation of $45 billion. Other companies are spread across two exchanges - such as dual-listed Singapore Telecommunications and dual-listed Telecom Corporation of New Zealand. Or they are less liquid, for example, 98 per cent of Hutchison Telecommunications' shares are tied up with majority owners and while TPG has 1.5 billion shares on issue, it is 37 per cent owned by its chief executive, David Teoh, and 26 per cent owned by investment group Washington H. Soul Pattinson.

Outside the top 200 are Macquarie Telecom, iiNet and M2 Communications.

iiNet has a market capitalisation of $512 million and recently paid a 6? interim dividend on shares which closed at a multi-year high of $3.18 this week. iiNet has benefited from recent positive news flow, such as resolving a long-running copyright court case, from which it expects to recoup about $6 million of its $9 million legal fees, and beneficial regulatory decisions on Telstra's wholesale pricing.

In the past two years, iiNet has snapped up AAPT's retail customers, TransACT, and Internode. This gave it a 16 per cent market share in DSL broadband.

TPG is about three times the size of iiNet and recently reported net profit of $55.7 million for the six months to January, up 65 per cent on the previous corresponding period. It raised its interim dividend 22 per cent to 2.75? a share. It has been trading at two-year highs of $1.90 since its half-year results and better than expected sales to corporate customers.

"We maintain 'buy' with $1.89 per share price target (previously $1.83 per share) given organic growth and potential for medium term earnings upside from both new services and demand [for corporate services] not currently in our numbers," Commonwealth Bank's global markets research team wrote in a note to clients. TPG expects strong demand for its "dark fibre" network - very high capacity inter-city fibre connections.

Small-business specialist M2 surprised the market recently with news it would buy retailer iPrimus - a quiet performer previously owned by North American parents. M2 hit a closing price of $3.06 this week, following a 40? slide since the start of April. But Canaccord BGF analyst Warren Jeffries has a bullish $5.10 target price for the stock following its "strategic and highly complementary" acquisition of Primus.

"The Primus business will provide a quantum leap in earnings for the group, while also resulting in MTU establishing itself as the fifth largest telecommunications company in Australia with the combining of the seventh (MTU) and eighth largest businesses," he wrote in a recent note to clients.

More consolidation is likely in coming years as the national broadband network changes the industry landscape and telcos scramble to build scale and lock in customers. The NBN gives telcos access to customers they have never been able to serve before. For example, Vodafone plans to start selling services on the fibre-optic network and iiNet has recently started selling satellite broadband services for the first time.

In the past, Telstra was the only telco able to access all households, although it does sell wholesale services to other carriers. Nationwide, there are 10.6 million services in operation on the copper network but only about 1.6 million are connected to competitors' equipment, according to the competition watchdog's latest report competition in the telco industry.

And the national broadband network provides an indirect subsidy, as the government pays for infrastructure all telcos will use to sell services.

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